Wednesday, October 19, 2016

Edward Lambert — Yellen wants to understand effective demand

Janet Yellen is really asking for research into effective demand. She sees a weakness in aggregate demand affecting aggregate supply… or potential output. That is effective demand, but she cannot even use the term effective demand because economists do not understand it.
I have been researching effective demand for 4 years. I have seen really a complete lack of understanding of what effective demand is among economists. It surprises me that Janet Yellen would be calling for research on its dynamics....
Janet Yellen just might understand more about Keynes and Post Keynesianism that she wants to let on publicly. She was excoriated as a "Keynesian" by economists on the right at the time of her appointment to the Fed chair. Maybe she is nudging without rocking the boat too much.

Has anyone read Yellen, Janet L, 1980. "On Keynesian Economics and the Economics of the Post-Keynesians," American Economic Review, American Economic Association, vol. 70(2), pages 15-25, May. (Link is to JSTOR. Registration required.)

She may be considered a New Keynesian, but this paper shows that she is at least familiar with some Post Keynesian thinking.

Angry Bear
Yellen wants to understand effective demand
Edward Lambert

So whilst Janet gets empirically what is wrong with modern macro research she misses the fundamental reasons this matters.
  1. Economics must be rebuilt around balance sheets and fundamental accounting identities
  2. Hence state – balance sheets- must be the basis of all models. If the model is not a state machine it cannot describe the state of anything economic.
  3. Hence credit and debt, and money matters
  4. As debt issues are fundamentally non linear and complex models which require linearisation, such as DGSE, must be discarded, they are too broken to be fixed.
Decisions, Decisions, Decisions
Yellen Almost, but not Quite, Gets Whats wrong with Modern MacroAndrew Lainton


Matt Franko said...

We are in perpetual surplus.....

peterc said...

"Janet Yellen just might understand more about Keynes and Post Keynesianism that she wants to let on publicly. She was excoriated as a "Keynesian" by economists on the right at the time of her appointment to the Fed chair. Maybe she is nudging without rocking the boat too much."

Probably true, I'd say. Being on the frontier of mainstream economics seems to be about working ideas from taboo areas into the mainstream framework. I remember Akerlof mentioning that Yellen encouraged him to model his market-for-lemons paper in an orthodox way when at the time Akerlof might otherwise have taken a less orthodox path (which, as he noted, would then probably have prevented publication in a leading journal).

More generally, though, I do think there is something quite obvious to most of us here that is not so obvious to mainstream economists, and this "something" makes it more difficult for them to conceive of demand-led growth.

For growth to be thought of as demand led, there must be a component of demand that is autonomous in the long run.

For neoclassicals, demand is considered entirely induced in the long run. In particular, they see private investment as responding endogenously to interest rates, and govt as facing a budget constraint.

When demand is considered entirely endogenous in the long run, then the only way long-run supply could be affected by demand is for short-run demand effects to have long-lasting impacts on supply (hence hysteresis-type arguments, which are valid as far as they go).

But, with currency sovereignty, it is clear that govt spending is autonomous, even in the long run. Therefore, even if private investment is treated as endogenous in the long run -- though induced by income growth (higher rates of capacity utilization) rather than interest rates -- and private debt-financed consumption is considered constrained in the long run (which it is, as the GFC testifies), it is clear that a currency-issuing govt is always a source of autonomous spending, and is not constrained by a neoclassical govt budget constraint.

If, for instance, government consumption expenditure grows at a fairly steady rate over time (which adds demand but not productive capacity to the economy), this will tend to increase rates of capacity utilization and induce additional investment to expand capacity.

Of course, there is also an important role for public investment expenditure, and this too adds demand as well as enhancing infrastructure and the profitability of private investment.

Ralph Musgrave said...

My pet cat understands how to increase effective demand: print fiat and give it to people and / or spend the money on infrastructure and the other usual public spending items: education, law and order, etc.

Unfortunately that's way too simple for professional economists: I mean how are you supposed to write incomprehensible, jargon strewn papers, complete with mathematical models if things are that simple?

peterc said...

This is a bit off topic, but perhaps it is worth mentioning that, historically, Harrod's original growth model did demand some kind of response. It was both extremely insightful but also problematic, because the knife edge suggested a kind of instability that was much more extreme than what we actually see in reality.

Solow's neoclassical response was to make the capacity-output ratio variable and responsive to interest rates. This was in line with neoclassical theory in which demand is considered induced in the long run. This, of course, introduced all the problems exposed in the capital debates and later work by neoclassical general equilibrium theorists, but many neoclassicals seem content to ignore those. Solow's solution also created the opposite problem to Harrod's original model. Whereas Harrod's growth process was too unstable to be plausible, Solow's model was too smooth and automatic to be plausible.

A better response to Harrod's knife edge IMO is the one proposed by some proponents of the classical surplus approach (starting with Franklin Serrano They note that Harrod, by way of simplification, assumed that all demand is induced. (He assumed the simplest possible consumption function C = cY instead of perhaps C = Co + cY, and also assumed private investment was entirely induced in accordance with the accelerator principle. The model was also closed without govt, leaving no role for autonomous demand.)

Serrano and others have argued that it is actually this simplification that causes Harrod's model to exhibit an extreme instability rather than the more moderate instability we see in reality. Once a role is introduced for autonomous expenditures that do not add to (private sector) capacity, the difficulty is resolved, and demand-led growth is conceivable. Firms operating with planned degrees of spare capacity (to cover unanticipated fluctuations in demand) respond to growth in autonomous demand, income and induced consumption that push output persistently above planned rates of capacity utilization by installing additional capacity in an effort to restore utilization rates to normal. In doing so, there will usually not be a knife-edge type explosion into hyperinflation because there will be enough spare capacity remaining to more or less absorb the immediate demand effects of the new investment expenditure prior to the lagged expansion of capacity. There might well be some temporary inflationary impact, but not an explosive one.

Neil Wilson said...

"print fiat and give it to people"

If you do that then you are paying them twice. Once with the goods they can buy with the money, and again with the output they produce during the day they get to keep for themselves.

And that means that those that receive the money have less stuff on offer, and less available stuff for them to buy. The extra money received is useless to them because there is no additional free production for exchange.